Abstract
A perfectly competitive firm has no need for marketing. Price and firm demand are exogenously determined, making price competition impossible. Expensive advertising campaigns are unprofitable because advertising can have no effect on firm demand. The only thing the firm must decide is how much output to produce and bring to market.
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Notes
- 1.
Formally, price discrimination does not exist for products i and j that are of like quality when p i /mc i = p j /mc j , even if p i ≠ p j .
- 2.
Consumer surplus is 50(120 − 70)/2, producer surplus is 50(70 − 20), and total surplus is consumer surplus plus producer surplus.
- 3.
In this case, consumer surplus is 100(120 − 20)/2.
- 4.
More formally, the firm’s total revenue of producing q′ can be described by an integral, which sums up the demand price when q ranges from 0 to q′. Formally, this can be written as \( \int_{{q = 0}}^{{q^{\prime}}} {D(q^{\prime})dq} \). Total cost is TC(q′). The firm’s problem is to maximize its profit with respect to output, where profit is π = \( \mathop{\int }\nolimits D(q)dq - {\hbox{TC}}(q) \). Because the derivative of \( \mathop{\int }\nolimits D(q)dq \) is D(q), the first-order condition is D(q) − MC = 0. That is, the profit-maximizing level of output occurs where D(q) = MC.
- 5.
The price does not remain constant, and this causes a consumer’s budget line to be nonlinear. See Varian (2010, 28–29) for further discussion.
- 6.
The process of identifying the optimal pricing scheme is rather tedious, so we will not discuss it here. For a more detailed discussion, see Varian (2010, Chap. 25).
- 7.
That is, π * = (p − AC)Q = (7 − 2)5.
- 8.
In this case, π * = (p − AC)Q = (5.5 − 2)7 = 24.5.
- 9.
This need not always be the case, however. We will see in a review question at the end of the chapter that some children will enter the resort when marginal cost is sufficiently low.
- 10.
The problem is more complicated when marginal cost is not a constant, because greater sales in one market causes marginal costs to change overall. For further discussion, see Pindyck and Rubenfeld (2009, Chap. 11).
- 11.
This assumes that the utility of adults is not raised or lowered by having children present.
- 12.
Recall that the price elasticity of demand (η) is the absolute value of the slope of demand (∂Q/∂p) times the equilibrium price divided by the equilibrium quantity. For both adults and children, ∂Q/∂p = –1. For adults, p * = 7, Q * = 5, and η A = 1.4. For children, p * = 4, Q * = 2, and η C = 2.
- 13.
For a more recent study of the use of coupons in the breakfast cereal industry, see Nevo and Wolfram (2002).
- 14.
Of course, children could be priced out of the market if costs are sufficiently high.
- 15.
- 16.
In addition, firms may use price discrimination to reduce competition, an issue we take up in Chap. 20.
- 17.
For further discussion, see Paul (2010). You can see a Mad TV performance of this song on YouTube, http://www.youtube.com, accessed May 23, 2010.
- 18.
For a list of companies that offer free samples, see the Shop4Freebies Web site at http://www.shop4freebies.com, accessed July 10, 2011.
- 19.
In the case of rational addiction, as in Becker and Murphy (1988), consumers consider both the past and the future. Behavioral economics suggests that at least some consumers are myopic, however (e.g., Akerlof and Dickens, 1982).
- 20.
To read more about the theory of peak-load pricing, see Crew et al. (1995).
- 21.
- 22.
The first to formally address this idea was Oi (1971), who was inspired by the two-part pricing strategy used at Disneyland in the 1960s. Disneyland and Disneyworld only charge a fixed entry fee today, however, perhaps to lower consumer time spent waiting in line.
- 23.
This discussion also holds for many consumers with identical demand functions.
- 24.
You can verify this by comparing profits for different prices and fixed fees.
- 25.
This assumes that fee discrimination is uneconomic (i.e., the firm cannot charge a higher fee to the high-valuation consumer).
- 26.
For a more detailed discussion, see Oi (1971) and Bernheim and Whinston (2008, Chap. 18).
- 27.
This will cost $39.89 ($29.99 + $0.45 · 22), whereas all other plans will cost $39.99.
- 28.
This information is available at http://www.consumerreports.org, accessed December 22, 2009.
- 29.
According to Naughton (2002), Wal-Mart is the “Everyday Low Price” king among discount stores.
- 30.
A similar argument would apply to consumers. If Sears tires were always on sale on the first week of the month, this information would become common knowledge and consumers would purchase tires only during sale periods.
- 31.
Federal Trade Commission, 277, 281 (1957). For further discussion of this case, see V. Tremblay and C. Tremblay (2005).
- 32.
For a more complete discussion of a generalized war of attrition, see Bulow and Klemperer (1999).
- 33.
For a more complete discussion of the war of attrition in brewing, see V. Tremblay and C. Tremblay (2007) and Iwasaki et al. (2008). This discussion ignores the growth in numbers of the microbreweries, as they produce darker lagers and ales that compete with imports more than the light lagers produce by the mass-producing brewers. See V. Tremblay and C. Tremblay (2005) for more discussion of the microbrewery movement.
- 34.
In these examples, firms do not engage in blatant deception and dishonesty. Instead, their primary goal is to exploit our inherent weaknesses. See Lindsey-Mullikin and Petty (2011) for a list of firm pricing strategies and rewards promises that are more deceptive in nature. Deception and puffing, especially associated with advertising, will be discussed in more detail in later chapters.
- 35.
- 36.
For example, would you spend an hour of your time in exchange for a free package of gum, a 100% discount?
- 37.
For a more complete discussion, see Stigler (1968, Chap. 15).
- 38.
Note that any other price option will earn the firm less profit. For example, sales are 0 at a price above 100. At a price of 39, 2 units will be sold for a profit of 78.
- 39.
For a discussion of additional cases where bundling increases firm profits, besides when consumers have negatively correlated demand functions, see McAfee et al. (1989).
- 40.
International Business Machines Corp. v. U.S., 298 U.S. 131, 139-140 (1936).
- 41.
- 42.
- 43.
This begs the question of how firms know that many consumers underestimate their variance of use. Because a considerable amount of money is at stake, cell phone companies hire economists to estimate consumer demand. They have also learned from trial and error.
- 44.
See http://www.oreck.com/customer-service/30-day-risk-free-trial.cfm, accessed May 27, 2010.
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Tremblay, V.J., Tremblay, C.H. (2012). Price Discrimination and Other Marketing Strategies. In: New Perspectives on Industrial Organization. Springer Texts in Business and Economics. Springer, New York, NY. https://doi.org/10.1007/978-1-4614-3241-8_14
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